[Federal Register Volume 69, Number 29 (Thursday, February 12, 2004)]
[Notices]
[Pages 7058-7060]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-3109]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49194; File No. SR-CBOE-2003-59]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by the Chicago Board Options 
Exchange, Inc. Relating to the Exchange's Obvious Error Rule

February 5, 2004.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on December 22, 2003, the Chicago Board Options Exchange, Inc. 
(``CBOE'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
items I, II, and III below, which items have been prepared by the CBOE. 
On January 20, 2004, CBOE submitted Amendment No. 1 to the proposed 
rule change.\3\ The Commission is publishing this notice to solicit 
comments on the proposed rule change, as amended, from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Steve Youhn, Legal Division, CBOE, to Nancy 
J. Sanow, Assistant Director, Division of Market Regulation 
(``Division''), Commission, dated January 16, 2004. Amendment No. 1 
amended the introductory paragraph of CBOE Rule 6.25 to clarify that 
existing paragraphs (b)-(e) of CBOE Rule 6.25 will apply to the 
adjustment and nullification of open outcry transactions in the 
exact same manner that they apply to electronic transactions. 
Amendment No. 1 also amended the title of CBOE Rule 6.25 to 
eliminate the word ``Electronic.''
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    CBOE proposes to extend portions of its obvious error rule to open 
outcry transactions. Proposed new language is italicized; proposed 
deletions are in [brackets].
* * * * *

Rule 6.25 Nullification and Adjustment of [Electronic] Transactions

    This Rule governs the nullification and adjustment of options 
trades [executed electronically and has no application to options 
trades executed in open outcry]. Paragraphs (a)(1), (2), and (6) of 
this Rule have no applicability to trades executed in open outcry.
    (a)-(e) No change.

Interpretations and Policies * * *

    .01--.02 No change.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of, and basis for, the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
item IV below. The Exchange has prepared summaries, set forth in 
sections A, B, and C below, of the most significant aspects of such 
statements.

[[Page 7059]]

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    On November 24, 2003, the Commission approved CBOE's obvious error 
rule,\4\ which establishes six specific objective guidelines that may 
be used as the basis for adjusting or nullifying a transaction. The 
Exchange specifically limited application of the obvious error rule to 
trades executed electronically, the premise being, according to CBOE, 
that parties to an open outcry trade would have an opportunity to 
evaluate whether to enter into a transaction prior to actually 
consummating that transaction. Therefore, if the market maker 
determined to make the trade after evaluating all available 
information, he shouldn't be able to reconsider the decision after the 
trade occurred. Recent events have proved that while this is generally 
a sound premise, instances outside of the control of the Exchange and 
the parties to a trade necessitate a different conclusion. For this 
reason, the Exchange proposes to amend its obvious error rule to make 
certain limited portions of the rule applicable to open outcry trades.
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    \4\ See Securities Exchange Act Release No. 48827 (November 24, 
2003), 68 FR 67498 (December 2, 2003) (File No. SR-CBOE-2001-04).
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    Specifically, CBOE proposes to extend the application of CBOE Rule 
6.25(a)(3), (4), and (5) to open outcry trades. CBOE also proposes that 
existing paragraphs (b)-(e) of CBOE Rule 6.25 would apply to the 
adjustment and nullification of open outcry transactions in the exact 
same manner that they apply to electronic transactions.
    CBE Rule 6.25(a)(3), (4), and (5) cover: Verifiable Disruptions or 
Malfunctions of Exchange Systems, Erroneous Print in the Underlying, 
and Erroneous Quote in the Underlying. Market makers base their quotes 
off of the underlying and each of these provisions covers instances 
where the information the market maker is using to price options is 
erroneous, through no fault of their own. For instance, with respect to 
sections (4) and (5) of CBOE Rule 6.25, an erroneous quote or print in 
the underlying means that the market maker is receiving erroneous 
information from the underlying market, which he then incorporates into 
his quotes. In these instances, CBOE represents that the market maker 
has little if any chance of pricing options accurately. CBOE believes 
that the same rationale as to why these provisions apply to electronic 
trades should apply to open outcry trades.
    CBOE offers the following example: assume that the Nasdaq Stock 
Market reports bad trades and then, pursuant to its NASD Rule 11890, 
either nullifies or adjusts them. During this period, assume 10 trades 
execute on CBOE, eight of which occur electronically, and two of which 
occur in open outcry. The Exchange, pursuant to CBOE Rule 6.25(a)(4), 
can adjust or nullify the electronic trades; however, it can do nothing 
regarding the open outcry trades. CBOE believes that this is certainly 
an unintended and inequitable result.
    The Exchange does not propose to extend the application of sections 
(a)(1) (Obvious Price Error), (a)(2) (Obvious Quantity Error), and 
(a)(6) (Trades Below Intrinsic Value) of CBOE Rule 6.25 to open outcry 
trading. With respect to subparagraph (a)(1) (Obvious Price Error), 
CBOE believes that if a market maker receives accurate underlying 
pricing information and gives an inaccurate quote, he must live with 
the consequences of his actions. This also applies to instances in 
which the market maker gives a verbal quote with a bigger size than 
intended or where he inadvertently prices an option under parity.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with section 6(b) of the Act \5\ in general, and furthers the 
objectives of section 6(b)(5) \6\ in particular, in that it is designed 
to prevent fraudulent and manipulative acts and practices, to promote 
just and equitable principles of trade, to remove impediments to and 
perfect the mechanism for a free and open market and a national market 
system, and, in general, to protect investors and the public interest. 
CBOE believes that the proposal provides for the adjustment or 
nullification of trades executed at clearly erroneous prices due to the 
receipt by the market maker of inaccurate pricing information that he 
uses to price his markets. CBOE notes that the exact same provisions 
have already been approved in the context of electronic trading.\7\
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    \5\ 15 U.S.C. 78f(b).
    \6\ 15 U.S.C. 78f(b)(5).
    \7\ See supra note 4.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE does not believe that the proposed rule change will impose any 
burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    No written comments were solicited or received with respect to the 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding, or (ii) as to 
which the Exchange consents, the Commission will:
    (A) By order approve such proposed rule change; or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609. Comments should be submitted electronically at the 
following e-mail address: [email protected]. All comment letters 
should refer to File No. SR-CBOE-2003-59. This file number should be 
included on the subject line if e-mail is used. To help the Commission 
process and review your comments more efficiently, comments should be 
sent in hard copy or by e-mail but not by both methods. Copies of the 
submission, all subsequent amendments, all written statements with 
respect to the proposed rule change that are filed with the Commission, 
and all written communications relating to the proposed rule change 
between the Commission and any person, other than those that may be 
withheld from the public in accordance with the provisions of 5 U.S.C. 
552, will be available for inspection and copying in the Commission's 
Public Reference Room. Copies of the filing will also be available for 
inspection and copying at the principal offices of the Exchange. All 
submissions should be submitted by March 4, 2004.


[[Page 7060]]


    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\8\
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    \8\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-3109 Filed 2-11-04; 8:45 am]
BILLING CODE 8010-01-P